Domestic Debt and Sovereign Defaults

Enrico Mallucci

Journal of Money, Credit and Banking, 2022, vol. 54, issue 6, 1741-1775

Abstract: This paper examines how the internal–external composition of government debt affects the government's borrowing policy, sovereign risk, and welfare in a small open economy. To this end, I develop a dynamic stochastic general equilibrium model with endogenous default risk that includes both external and domestic debt. I calibrate the model to Argentina, and I show that the model closely reproduces key empirical moments. Moreover, I highlight the existence of an externality that distorts debt composition: Domestic debt levels are inefficiently low and default risk is inefficiently high. The welfare loss associated with the externality is roughly 0.7% when it is measured in permanent units of consumption. A Pigouvian subsidy that incentivizes domestic purchases of government bonds restores efficiency.

Date: 2022
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https://doi.org/10.1111/jmcb.12864

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Working Paper: Domestic Debt and Sovereign Defaults (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:54:y:2022:i:6:p:1741-1775

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